Are negative gearing tax breaks a useful incentive for investors or an anomaly that should be removed?
Rapidly escalating property prices and the investment opportunities they represent are shining a light on the role negative gearing plays in Australia’s economy. Three experts weigh in.
CEO, Grattan Institute
Negative gearing distorts investment, doesn’t materially reduce rents or increase construction, and makes home ownership less affordable. Many people benefit from negative gearing, but many more lose. It is an anomaly that should go.
Negative gearing allows investors to deduct recurrent losses from investments from their wages and salary income. These losses can include the interest on money borrowed to make an investment.
In theory, negative gearing is a general application of standard tax principles. In practice, negative gearing breaks mostly attract investors in property. Few banks are happy to lend to businesses for long when they have negative cash flow. Few investors are happy to borrow against shares if the interest cost is much higher than dividends.
The tax treatment of negative gearing distorts investment decisions. Investors can claim interest costs at their marginal rate of tax, while the capital gains from the investment are effectively taxed at a lower rate. As a result, most countries limit the deduction of losses on property investments against wage and salary income.
“Negative gearing simply drives up house prices.” John Daley
Bush economics claims that negative gearing reduces rents. More careful study suggests that negative gearing affects asset prices rather than returns. Rents did not increase in real terms in three out of five Australian cities when negative gearing was restricted between 1985 and 1987.
In theory, negative gearing promotes housing construction. In practice, more than 90 per cent of negatively geared properties are existing properties. Supply of new construction is primarily limited by land release and planning restrictions, so negative gearing simply drives up house prices.
The ability to deduct costs legitimately incurred in obtaining taxable earnings is an integral part of an income tax system. Indeed, “income” in such a system is defined as the difference between revenues and costs; if the system is to tax income, it must allow for the offsetting of costs.
In practice, there are invariably issues about the extent and nature of the costs that may be so offset. But it would be strange to conceive of an income tax system that did not recognise interest charges as an offset to revenue in determining taxable income.
“It makes no sense to alter our entire tax arrangements ... for the sake of addressing highly localised problems whose origins do not lie in the tax system itself.” Henry Ergas
An obvious problem with any system which did not do so is that it would give rise to double taxation of interest payments: they would be taxed once in the taxation of the borrower and then again when they were received as income by the lender. By raising the effective tax rate on capital, the result would be to deter otherwise efficient investment.
It is, of course, possible to conceive of a system which limited the ability to offset losses arising from interest payments. However, such quarantining sits uneasily with an income tax system such as Australia’s, which treats personal income on a comprehensive basis.
Why do house prices keep rising?
It may be that because of low interest rates and constraints on land supply property prices are higher than they should be, particularly in Sydney – but it makes no sense to alter our entire tax arrangements, departing from their underlying methodological foundations, for the sake of addressing highly localised problems whose origins do not lie in the tax system itself.
Paul Drum FCPA
Head of policy, CPA Australia
Allowing a tax deduction for expenses incurred in the derivation of one’s assessable income has been a basic tenet of our income tax system since its inception. In this context, negative gearing of active or passive asset investments is not a tax anomaly.
If the deductibility of expenses is wound back, this will have significant adverse flow-on effects on the Australian economy.
For example, it’s not hard to conclude it will negatively impact jobs, property investment and prices, slow the development of new housing stock and reduce long-term household wealth and retirement savings.
It’s also worth noting that one taxpayer’s deduction is generally another taxpayer’s income – so any current income tax revenue loss from negative gearing itself is only at the margin. But if abolished, this will negatively impact government tax revenues.
For example, at Australia’s federal level, it will mean lower income tax and GST revenue collections. At the state level, it will mean fewer conveyancing duty collections due to less activity in the property sector.
Related: The success of GST reform depends on the shape it takes
Passive investment options for most Australians are pretty much limited to interest-bearing deposits, listed securities and property.
In an era when we’re encouraging people to save for their retirement more than ever before, it is detrimental – and therefore inappropriate – to effectively take one of these options off the table by denying a legitimate deduction incurred in the derivation of one’s income.
If housing affordability is to be improved, then we should identify the blockages in the supply of new housing and address these – this will likely require non-income tax-centric responses.
“If housing affordability is to be improved, then we should identify the blockages in the supply of new housing.”
Paul Drum FCPA
John Daley is the chief executive of the Grattan Institute, a centrist public policy think tank, and is one of Australia’s leading public policy thinkers. He has 25 years’ experience in the public, private and university sectors. His work for Grattan has included the landmark cost-benefit analysis Game-changers: Economic reform priorities for Australia. He has worked for ANZ Bank and McKinsey & Company, and has expertise in law, finance, education and workers compensation.
Economist Henry Ergas is best known for his work on regulation and innovation. He is professor of infrastructure economics at the University of Wollongong’s SMART Infrastructure Facility and senior economic adviser to Deloitte Australia.
He has also worked as regional head, Asia-Pacific, for CRA International, managing director of Network Economics Consulting Group (NECG) Australia and adviser to Australia’s former Trade Practices Commission. In 1994 and 1995 he was a visiting professor at Harvard’s Kennedy School of Government, and he has been an adjunct professor at the University of Singapore and at Monash University.
Paul Drum FCPA
Paul Drum is head of policy at CPA Australia. He has worked in the tax and business policy arena for more than 30 years, principally in Australia but also in Hong Kong, Malaysia, Singapore and New Zealand. He is the immediate past chairman of the Association of Accounting Technicians (AAT Australia).
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